Get With The Plan: June 1, 2014

Lance and Olivia, both 54, have two grown children who still live at home — the youngest finishing the final year of college — but the couple are starting to think about their own retirement.

They’d love to be in the South on a golf course in the winter and stay in the North for summers so they can stay close to their children. Age 60 is their target.

While they have no credit card debt, cash flow is an issue.

“Our biggest challenge is that we do not have a lot of spare funds for everyday large expenses,” Lance says.

The couple, whose names have changed, have saved $115,100 in 401(k) plans, $861,000 in IRAs, $8,500 in a brokerage account, $7,000 in savings and $5,600 in checking.

The Star-Ledger asked Alan Meckler, a certified financial planner with Cornerstone Financial Group in Succasunna, to help the couple manage their cash flow and prepare for their future.

“They have a done a great job saving for their future retirement so far,” Meckler says.

And they’ve kept debt down to a minimum, but their home loan is costing them more than necessary. The remaining mortgage is only $16,700, but it has an interest rate of 6 7/8 percent, which is very high by today’s standards.

The loan is scheduled to be paid off in four-and-a-half years, but Meckler thinks they should make a change.

“Instead of refinancing to obtain a first mortgage and paying closing costs, they should consider a home equity loan at a much lower interest rate than what they have now,” he says. “Most of the banks offer home equity loans with no application or closing costs.”

That may help with the daily bills.

Lance and Olivia have less than $13,000 of cash on hand for emergencies, but Meckler recommends they boost that to $30,000 because typically they should have between three and six months of expenses banked for unexpected costs.

He says they can accumulate the funds by cutting back a little on 401(k) plan contributions, but not enough that they lose the company matching funds. Or they can cut back on their spending and redirect the money to a safe, liquid account.

Looking at their investments, Meckler says their assets are too overly weighted in qualified retirement plans. He says 401(k) and IRAs are great during the accumulation phase because of tax-deferral and tax-free growth. The downside is that when you take the money out in retirement, you’re taxed at ordinary income rates. And if you ever need to withdraw money before age 59½, you’re faced with an additional 10 percent penalty.

This is important to consider, Meckler says, because right now we’re in a historically low tax environment.

“In 1986, the top tax bracket was 50 percent, and 1981, it was 70 percent. My feeling is that taxes will go up,” he says. “They may want to consider and hedge their bets somewhat and ask if the employer can give a Roth option to the 401(k).”

With the Roth, you contribute after tax-dollars to the plan, all the growth is not taxed and eventually, when you start withdrawals, it is also tax-free. Meckler says this is the way to go if you feel taxes will be higher in the future.

For his retirement analysis, Meckler assumed an annual rate of return of 6 percent on their investable assets, a 3 percent inflation rate for general living expenses and a 3 percent inflation rate for Social Security. He also assumed Lance will continue funding his 401(k) until retirement, and that the couple would continue the same spending in retirement with a 3 percent annual inflation rate. And finally, he assumed they’d start Social Security at their full retirement ages.

“When to begin Social Security is a very important planning technique,” he says. “They may very well want to wait until age 70 to begin, depending on health issues and other factors. Each year they wait the benefit will go up by 8 percent.”

Assuming these parameters, they will be able to retire at age 60 comfortably, Meckler says, but he warns that they should update their plan each year to make sure they’re on target.

“If the stock market has a couple bad years, especially when you are taking income from your portfolio, it can dramatically affect your assets,” Meckler says.

That brings us to asset allocation. Lance’s IRA is 78 percent in equities, and his 401(k) is 100 percent in equities. Olivia’s IRA is 94 percent in equities.

“The majority of their equity positions are large-cap stocks and their fixed income is in U.S. Treasury securities,” Meckler says. “I’m sure they were very happy with their returns last year but they are definitely not diversified and taking on way too much risk.”

In the coming years, he recommends they consider scaling back on stocks so they don’t take on more risk than necessary.

“If you lose 10 percent in one year, you only need an 11 percent return the next year to get back to even,” he says. “If you lose 50 percent, you need a 100 percent return to get back to even. Being too aggressive can backfire in retirement.”

There are other considerations for Lance and Olivia.

Meckler says when most people plan for retirement, they only focus on their assets and pension plans.

“But in order to be successful, you need to make sure you have all of your risk insurance in place and the proper amounts.,” he says. “These include the proper limits and deductibles for auto, homeowners, umbrella, disability, medical, long-term care insurance and life insurance.”

Lance and Olivia do not have disability or long-term care policies.

At their ages, disability insurance is expensive, Meckler says, and with retirement in six years, disability is not as critical as long-term care insurance.

“The annual cost for assisted living or nursing home care can easily cost $100,000 per year and would significantly impact their assets,” Meckler says.